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Investing Specialists

The Economy Looks Great...What About the Market?

The recovery is slowing but still rolling.

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The economic news looked great this week, and earnings data out of the tech, industrial, and financial sectors continued to impress. Unfortunately, off-again on-again bailouts for Greece, continued negative news flow out of  Goldman Sachs  (GS), and a "sell stocks on the good news" mentality kept volatility high all week, closing on a very sour note Friday after one of the best gains of the year just the day before.

GDP Growth Looks Good, Though not Quite as Good as My Expectations
GDP growth, the broadest measure of economic activity, managed to match the 3.2% consensus forecast but fell short of my 4% target. The part of the number that really matters, consumption expenditures, did manage to fall within my forecast range. The Chicago ISM Purchasing Managers' report was also impressive, indicating that the manufacturing sector continues its strong bounce off the bottom. Transportation data from both the rail and trucking sectors were also exceptionally robust according to our industrials team. Lower delinquencies and much higher spending rates are beginning to drive earnings for major credit card companies.  American Express (AXP) and  Capital One (COF) both reported powerful results according to Morningstar's financial team. Initial unemployment claims again moved in the right direction this week. During past recoveries, initial unemployment claims improvement has stalled out at a similar point with no detrimental effect on the economy. Rolling this week's news all together, I am sticking with my overall economic forecast for 4.5% growth in 2010, though the first-quarter report will make that target just a little harder to attain.

Forecasting the Economy Is not the Same as Forecasting the Stock Market
Just as one word of caution, I generally view my role as one of forecasting economic activity and not the stock market. While I remain adamant that economic activity will continue to improve and that the economy will not see a double dip, that doesn't necessarily mean the market will continue to move up in a straight line, especially in the short run. Currently, Morningstar's proprietary metric, price to our analyst calculated fair value, is now at 1.07 meaning the market overall is about 7% overvalued if our models are correct. Historically, the price/fair value metric has ranged from a low of 0.55 to as high as 1.14. That doesn't mean the market should go straight down from here. The price/fair value metric remained above or very close to 1 for the entire period from 2003 to 2007 before the market finally began to collapse in late 2007. The current market seems awfully skittish at any hint of bad news and is not responding very well to good news. In addition, the summer doldrums of stock market trading loom in the months ahead. Morningstar would seldom advocate any type of short-term trading, but it might make sense to check your asset allocations and rebalance where necessary to avoid taking on too much risk.

Robert Johnson, CFA does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.